NOT MILTON

Bad debt: Why Bush's deficits will slow America's growth (Benjamin M. Friedman, 7/27/2003, Boston Globe)

The root of the problem is that America has always been a low-saving country. The fraction of our incomes that we put aside, together with the fraction of earnings that our companies retain rather than paying out in dividends, adds up to a smaller share of our national income than what the typical European country saves, and a smaller share than what some of the fast-growth countries in East Asia normally save.

When the government spends more than it takes in from taxes-that's what running a deficit means-the Treasury has to borrow in the financial markets to cover the overage. This borrowing absorbs some of the saving done by families and firms, saving that otherwise would have remained available to finance investment in productive new plant and equipment. People who put their savings into banks, or money-market mutual funds, don't think of themselves as financing the government's deficit. But when these institutions use the deposited funds to buy Treasury securities, that's exactly what they are doing.

If we had a saving rate like Italy's (11 percent) or Korea's (above 13 percent), having the Treasury absorb an amount of our saving equal to a few percentage points of our national income would be of little concern. But over the last 10 years the total amount of saving done by the private sector of our economy, beyond the amount needed merely to replace the factories and houses that are wearing out (in other words, the saving that is available to enable the economy to do more than just keep running in place), has averaged not even 6 percent of US national income. If the government's deficit averages 2 percent of national income later this decade, as the latest Bush administration predicts, it will therefore take up more than one-third of America's net saving. More likely, the deficit will be larger and so will the share of our national saving it absorbs.

When a similar situation occurred during the Reagan administration (when the deficit averaged 4.2 percent of national income), defenders of the president's policy offered a variety of stories about how the saving rate would rise, or how business could be productive and wages rise without new investment, or how some other break with prior experience would solve the problem. Those ideas were intellectually interesting. But they also proved wrong. During the big-deficit years of President Reagan and the first President Bush, the share of US national income devoted to net new investment in plant and equipment fell to the lowest average level in the postwar period, and real wages-and therefore the income of the typical US family-stagnated.

To make matters worse, in order to finance even the meager investment we were able to make during the Reagan-Bush years, with the government absorbing so much of our saving, America borrowed so much from abroad that we became the world's most highly indebted country. During the last few years, the United States has again been running a large trade deficit, and consequently has been borrowing heavily from foreign lenders, for reasons having little to do with the budget deficit. Business here may be weak, but it is stronger than in Europe or Japan or Latin America. We buy more than $100 billion in goods each year from China, but sell the Chinese little in return. If our government is still running a sizable budget deficit after our economy returns to full employment, that will only make the situation worse.

What's wrong with continual large budget deficits, maintained year after year even at full employment, is that they take away the economy's means of achieving economic growth.

Two salient facts make it nearly impossible to take this essay seriously:

(1) Repetition of the national savings rate canard--we've all heard these dire numbers before and there's some healthy residue of Puritanism that makes us want to flagellate ourselves for squandering our money instead of saving it. You'll have noticed that we are always compred to the notoriously drone-like Japanese and Germans, in order to make the numbers seem more plausible. But they are, of course, completely misleading. In order to arrive at such an absurdly low number for America's savings rate you have to exclude two rather significant things from the calculation: the home and the 401k. Factor these assets back into the equation and we actually have one of, if not the, highest savings rates in the world. Americans too save like worker bees, its just that, unlike many other countries, we both own our own hives and help fund our own golden years.

(2) Twenty years of uninterrupted growth at a higher rate than any other Western nation--the last two "recessions" (1991, 2001) were so shallow and so brief and economic numbers are so notoriously amorphous that folks have already beguin to question whether they even qualify as such or were merely periods of slowdown. But this much seems certain, that when you plot out the trend of the American economy over the last twenty years it certainly looks like a continuous, though somewhat unevenly paced, ascent. Moreover, if you plot out the annual debt against that growth line you'll find bno correlation between lower debt and faster growth. In fact, the latest slowdown corresponded precisely to the return of surpluses. This is not necessarily to argue--though I would--that the surplus led to or was a main contributor to the 2001 slowdown, but it does suggest that our budget deficits and surpluses have a more complicated relationship to our economic growth than Mr. Friedman allows. Posted by Orrin Judd at July 28, 2003 7:10 PM